December 29, 2008

Corporate Governance Group Client Alert Be i j i n g Fr a n k f u r t Ho n g Ko n g Lo n d o n Lo s An g e l e s Mu n i c h Ne w Yo r k Si n g a p o r e To k y o Wa s h i n g t o n , DC

Please feel free to discuss any aspect of this Client NY State Court Decision Alert with your regular Milbank contacts or with Relating to Bear Stearns any of the members of our Corporate Governance takeover Should Provide Group, whose names and contact information are Comfort to Corporate provided herein.

Directors Forced to take In addition, if you would like copies of our other Action in Unstable Markets Client Alerts, please contact any of the attorneys listed. You can also obtain this Court Defers to Business Judgment of Bear Stearns Directors and our other Client Alerts by visiting our website at in Connection with JP Morgan Merger http://www.milbank.com and choosing the “Client On December 4, 2008, in In re Bear Stearns Litigation,1 the New York Supreme Alerts & Newsletters” link under “Newsroom/ Court dismissed investor challenges to the federally-assisted acquisition of Bear Events”. Stearns by JPMorgan Chase. To our knowledge, this is the first judicial decision in the spate of shareholder class action lawsuits brought in the wake of the unprecedented meltdown of many of our leading financial institutions during 2008. The plaintiffs This Client Alert is in this class action, former Bear Stearns shareholders, sought (among other relief) a source of general damages from Bear Stearns’ directors for alleged violation of their fiduciary duties information for clients and in negotiating and approving the merger with JP Morgan. Relying on the business friends of Milbank, Tweed, judgment rule’s “presumption that in making a business decision, the directors of a Hadley & McCloy LLP. Its content should not be corporation acted on an informed basis, in good faith and in the honest belief that the construed as legal advice, action taken was in the best interest of the company,” Judge Cahn granted the director and readers should not act defendants’ motion for summary judgment, determining that the Court “should not, upon the information in and will not, second guess their decision.” this Client Alert without consulting counsel. The Court’s decision repeatedly emphasizes the unprecedented and dire straits in © 2008, Milbank, Tweed, which the Bear Stearns directors found themselves, characterizing their actions as an Hadley & McCloy LLP. attempt “to salvage some $1.5 billion in shareholder value and [avert] a bankruptcy All rights reserved. that may have returned nothing to the Bear Stearns’ shareholders, while wreaking havoc on the financial markets.” Given the gravity of the circumstances, and recognizing that this was a New York state court applying and interpreting Delaware law, the Bear Stearns ruling may have limited precedential value when the financial

1 In re Bear Stearns Litigation, N.Y. Sup. Ct., Index No. 600780/08 12/4/08. Corporate Governance Group

markets rebound. But it surely should be comforting to corporate directors forced to make difficult, and sometimes rushed, decisions in the current environment that courts remain willing to defer to the directors’ business judgment.

Background

The facts of Bear Stearns’ fall from grace are by now well known. During the week beginning Monday, March 10, 2008, Moody’s downgraded certain mortgage-backed debt issued by a Bear Stearns affiliate. As rumors concerning Bear Stearns’ liquidity and ability to continue in business flooded the marketplace, Bear Stearns customers began withdrawing billions of dollars and counterparties refused to continue doing business with the company. By the weekend, with the stock price plummeting and the company’s financial condition deteriorating rapidly, Bear Stearns determined that, without a stabilizing transaction or a bankruptcy filing, it would not be able to open for business on Monday morning. In response to continued pressure from federal regulators and an inability to obtain any alternate financing,2 on Sunday, March 16, 2008, the board of directors of Bear Stearns approved a stock-for-stock merger with JPMorgan pursuant to which Bear Stearns shareholders would receive $2 of JP Morgan stock for each of their Bear Stearns shares.3

The merger agreement negotiated by Bear Stearns and JP Morgan contained a number of provisions aimed at providing deal certainty for JP Morgan, including (i) an option for JP Morgan to purchase 19.9% of Bear Stearns’ stock at $2 per share, (ii) an option for JP Morgan to purchase the Bear Stearns headquarters for $1.1 billion and (iii) an agreement on the part of Bear Stearns not to solicit competing proposals. Following an outcry from Bear Stearns shareholders which raised the specter that they would not approve the transaction, the merger agreement was amended a week later to raise the merger consideration to $10 of JP Morgan stock for each Bear Stearns share.4 In addition, JP Morgan was given the right to purchase a 39.5% interest in Bear Stearns at $10 per share and the Bear Stearns directors agreed to resign at the effective time of the merger.5 Subsequently, JP Morgan purchased an additional 10% of the outstanding Bear Stearns shares on the open market, lifting its stake to 49.5%. On May 29, 2008, the merger was approved by Bear Stearns’ shareholders by a 71% vote.6

The Court Applies the Business Judgment Rule

The Court began its analysis of plaintiffs’ breach of fiduciary duty claim by tackling the threshold determination of the appropriate standard of review. The Court concluded that the least stringent standard of review, Delaware’s business judgment rule, should be applied. In so ruling, the Court rejected plaintiffs’ arguments for a heightened level of scrutiny of the board’s actions – and particularly the deal protection devices negotiated with JP Morgan – under either Unocal,7 Blasius8 or Revlon9:

2 During this period, Lazard solicited over a dozen potential merger partners for Bear Stearns, but ultimately only JP Morgan was in a position to move with the necessary speed and obtain the backing of the federal government. 3 In addition, JP Morgan agreed to guarantee immediately various obligations of Bear Stearns, and the New York Fed agreed to provide supplemental funding of up to $30 billion. 4 JP Morgan was particularly concerned by this development since its guarantee of Bear Stearns’ obligations, as drafted, continued for a year even if Bear Stearns shareholders rejected the transaction and the merger agreement terminated. 5 In addition, although the amended arrangements reduced the period of JP Morgan’s continuing guarantee to 120 days if the transaction was not completed, JP Morgan was forced by the NY Fed to guarantee Bear Stearns’ borrowings from the NY Fed and to assume up to the first $1 billion of any losses suffered by the NY Fed on its $30 billion loan to the company. 6 Had the 39.5% block of shares purchased by JP Morgan been excluded from the vote, the merger still would have passed with 52% of the vote; however, if all shares owned by JP Morgan shares were excluded, the transaction would have failed with a 42.7% vote. 7 Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1995). 8 Blasius Indus, Inc. v. Atlas Corp., 564 A.2d 651 (Del. Ch. 1988). 9 Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986).

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 With respect to Unocal, the Court noted that Unocal typically applies if an external hostile threat to corporate control had been initiated by a third party, but not in a case (such as this) where “the board initiates the transaction in the absence of such an external threat.” It should be noted that this line of reasoning is clearly at odds with a number of Delaware cases in which courts have applied a Unocal analysis to deal protection devices included in merger agreements.

 Next, with respect to Blasius, the Court noted that “its application has been largely limited to disputes over the election of directors” and that “the reasoning of Blasius is far less powerful when the matter up for consideration has little or no bearing on whether the directors will continue in office.” Continuing in this vein, the Court found no evidence that the “directors’ primary purpose in approaching the merger was to affect the shareholder franchise.”

 Finally, with respect to Revlon, the Court stated that “Revlon duties are not ordinarily implicated in a stock-for-stock merger of widely-held public companies,” and that neither the issuance of a 39.5% block of shares to JPMorgan nor its subsequent purchase of an additional 10% on the open market constituted a transfer of control. “Rather,” the Court noted, “the public shareholders retained ultimate control.”

Because, in the Court’s view, the plaintiffs “failed to establish that a heightened standard of review should be applied,” the Court invoked the business judgment rule, thereby placing the burden on the plaintiffs to demonstrate a breach of the duty of care or loyalty, or bad faith action, on the part of the Bear Stearns directors.10 In this regard, the Court concluded that there was “no evidence that the board – comprised of a majority of non- management, non-employee directors and assisted by teams of financial and legal advisers – acted out of self- interest or bad faith.” Moreover, the Court refused to give credence to expert opinions obtained by the plaintiffs, noting that they did “not take into sufficient consideration the very real emergency which the company faced, and the real time pressure under which Bear Stearns’ officers and directors were operating. The company could simply not continue to carry on its major operations on Monday morning, unless it had put some major financing, or a major transaction which would carry with it major financing, in place. No options appeared to be available other than the merger transaction with JPMorgan.” On this basis, the Court refused to “second guess” the board’s business judgment and granted the directors’ motion for summary judgment.

Hypothetical Heightened Scrutiny Application

Although the Court denied plaintiffs’ request to apply a heightened level of scrutiny, Judge Cahn opined that the “board’s efforts to preserve some shareholder value while averting the uncertainty of a bankruptcy – an event with potentially cataclysmic consequences for the broader economy as well as for the shareholders – would survive scrutiny even if some enhanced standard of review under Delaware law did apply.” In so ruling, the Court noted that:

 Consistent with the requirements of Unocal, the directors’ response was proportionate to the threat posed by the perilous state of Bear Stearns’ circumstances. “Bear Stearns’ very survival and the benefit to shareholders therefrom, depended on consummating a transaction with a financially sound partner. … Having contacted over a dozen other potential corporate parties without obtaining a viable alternative bid, its accommodation of JPMorgan’s contractual demands to insure increased deal certainty, and to placate the demonstrably unsettled market concerns, was neither ‘draconian’ nor outside the ‘range of reasonableness’.”

10 The Court also indicated that, based on the exculpatory provision contained in Bear Stearns’ certificate of incorporation pursuant to Section 102b(7) of the Delaware General Corporation Law, the Bear Stearns directors could not be held personally liable for damages arising from a breach of fiduciary duty unless the plaintiffs could demonstrate a breach of the duty of loyalty or bad faith on their parts; a finding of gross negligence implicating a breach of their duty of care would not suffice.

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 The considerations which supported a finding of the satisfaction of theUnocal standard also applied to the directors’ burden under Blasius. According to the Court, “a compelling justification [under Blasius]may be found where the ‘directors act for the purpose of preserving what the directors believe in good faith to be a value-maximizing offer’.” The Court cited (i)Bear Stearns’ rejection of JP Morgan’s demand to purchase a 66% stake in the company (as opposed to the 39.5% stake finally negotiated), (ii) the negotiated increase in the merger consideration from $2 to $10 per share, (iii) the presence of a majority of independent directors on the Bear Stearns board and (iv) “the record of the diligence of Bear Stearns’ board in confronting and resolving the crisis” as reasons for “leav[ing] little room for judicial review of its conduct.”

 A “satisfactory showing under Revlon has been made where, as here, the directors: were sophisticated and knowledgeable about the industry and strategic alternatives available to the company; were involved in the negotiation process and bargained hard; relied on expert advice; and received a fairness opinion from a financial advisor,” even though “the corporation is operating under extreme time pressure and can locate only one bona fide purchaser despite its best efforts to find competing offers.” According to the Court, application of enhanced judicial scrutiny involves a determination “whether the directors made a reasonable decision, not a perfect decision.”

North Carolina Court Concurs in Bear Stearns Analysis

On December 5, 2008, just one day following the issuance of the Bear Stearns decision, a shareholder’s motion for preliminary injunctive relief in the pending Wachovia/Wells Fargo merger was denied by the North Carolina Superior Court.11 Wells Fargo filed a Notice of Supplemental Authority with the Court, which attached a copy of Judge Cahn’s Bear Stearns decision. The North Carolina court ruled in favor of the director defendants, finding that the Wachovia board satisfied its responsibilities under the business judgment rule in light of the economic circumstances, including liquidity problems as a result of widespread market troubles and the extended run on Wachovia’s bank deposits.12 Judge Diaz, applying North Carolina law but citing the Bear Stearns decision and quoting liberally from Delaware Chancery Court decisions, concluded that while the case “does not fit neatly into conventional business judgment rule jurisprudence, which assumes the presence of a free and competitive market to assess the value and merits of a transaction,” the Wachovia board’s “decision- making process, although necessarily compressed given the extraordinary circumstances confronting it, was reasonable and fell within the standard of care demanded by law.”

Conclusion

It will be interesting to see if other courts, and particularly the Delaware Court of Chancery, follow the lead of the Bear Stearns Court in deferring to the business judgment of corporate directors forced to take momentous, time-pressured actions in response to the unprecedented economic and financial circumstances prevalent during 2008. Although the deference granted to the directors in the Bear Stearns decision should be of comfort to corporate directors who find themselves in similarly dire straits, it is not likely that the ruling will herald a new era of judicial deference to corporate decision makers. Rather, once the markets calm, increased federal regulation will surely follow and the courts will have many opportunities to second guess corporate decisions and policies.

11 Ehrenhaus v. Baker, 2008 NCBC 20. 12 It should be noted that, unlike the case law in Delaware, the North Carolina corporate statutes expressly provide that the business judgment rule is the appropriate standard for reviewing director conduct, whether in a change of control situation or otherwise.

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Please feel free to discuss any aspect of this Client Alert with your regular Milbank contacts or with any of the members of our Corporate Governance Group, whose names and contact information are provided below.

Beijing Units 05-06, 15th Floor, Tower 2 China Central Place, 79 Jianguo Road, Chaoyang District Beijing 100025, China Anthony Root +86-10-5969-2777 [email protected] Edward Sun +86-10-5969-2772 [email protected]

Frankfurt Taunusanlage 15 60325 Frankfurt am Main, Germany Norbert Rieger +49-69-71914-3453 [email protected]

Hong Kong 3007 Alexandra House, 18 Chater Road Central, Hong Kong Anthony Root +852-2971-4842 [email protected] Joshua Zimmerman +852-2971-4811 [email protected]

London 10 Gresham Street London EC2V 7JD, England Stuart Harray +44-20-7615-3083 [email protected] Thomas Siebens +44-20-7615-3034 [email protected]

Los Angeles 601 South Figueroa Street Los Angeles, CA 90017 Ken Baronsky +1-213-892-4333 [email protected] Neil Wertlieb +1-213-892-4410 [email protected]

Munich Maximilianstrasse 15 (Maximilianhoefe) 80539 Munich, Germany Peter Nussbaum +49-89-25559-3636 [email protected]

New York One Chase Manhattan Plaza New York, NY 10005 Scott Edelman +1-212-530-5149 [email protected] Roland Hlawaty +1-212-530-5735 [email protected] Thomas Janson +1-212-530-5921 [email protected] Robert Reder +1-212-530-5680 [email protected] Alan Stone +1-212-530-5285 [email protected] Douglas Tanner +1-212-530-5505 [email protected]

Singapore 30 Raffles Place, #14-00 Chevron House Singapore 048622 David Zemans +65-6428-2555 [email protected] Naomi Ishikawa +65-6428-2525 [email protected]

Tokyo 21F Midtown Tower, 9-7-1 Akasaka, Minato-ku Tokyo 107-6221 Japan Darrel Holstein +813-5410-2841 [email protected] Bradley Edmister +813-5410-2843 [email protected]

Washington, DC International Square Building, 1850 K Street Washington, DC 20006 Glenn Gerstell +202-835-7585 [email protected] 5